China rail reform back on track after scandal

Investors may hop aboard more projects, but only if reforms go deep

YuNing

GuYongqiang

BEIJING (Caixin Online) — The Communist Party recently expelled former railways chief Liu Zhijun for disciplinary violations and handed the case to judicial authorities for a criminal trial.

The progress for Liu’s prosecutors parallels efforts to speed up financial and operation reforms at the Ministry of Railways, which runs the nation’s network of passenger and freight lines, track construction companies and train manufacturing.

As part of the long-anticipated reform effort, the central government in May announced plans to open the rail system to private investors, decentralize the contract bidding process and increase rates for freight customers.

Contractors welcomed the change in the bidding system which, according to representatives from several railway suppliers, was easily manipulated in the old days before Liu’s corruption was exposed.

About Caixin
Caixin is a Beijing-based media group dedicated to providing high-quality
and authoritative financial and business news and information through
periodicals, online and TV/video programs.
• Get the Caixin
e-newsletter

“Before Liu Zhijun was ousted,” said one contractor, “basically all the tender results were artificially manipulated.”

Moreover the rail agency, now led by Sheng Guangzu, recently got State Council permission to hike borrowing to what could be 150 billion yuan
USDCNY, +0.4041%
this year, compared to 100 billion yuan annually in recent years.

More borrowing power could help the ministry bounce back from a 50 percent decline in spending in the first quarter, compared to the same period 2011.

Officials are wondering how far to go with rail reform. Caixin has learned the National Development and Reform Commission (NDRC) is asking fresh questions, and feasibility studies are apparently being conducted by rail ministry officials with NDRC’s Commission for Economic Restructuring and Department of Basic Industries.

A source participating in the studies said debates have focused on whether the railway should separate its freight and passenger businesses, and whether provincial or regional governments should take over sections of the railroad.

Cautious capital

The indebted ministry, under pressure from the State Council, has invited private companies to consider building railroads, supplying equipment and providing services.

Private investment and local governments in the past have dabbled with joint-venture railroads, but efficiency was poor.

An NDRC source said the ministry in the past moved toward opening operations to private investors, but failed to lift key barriers. This so-called “glass door” still separates the ministry’s operations from private companies in many areas, such as track construction.

“Freight services were liberalized in the past, but the Ministry of Railways made it hard for private railways to link to the national system,” the source said.

The ministry has also promised to make it easier for private investors to obtain financing for rail construction projects and to streamline the administrative approval process.

So far, however, the ministry has yet to address questions about reforming its price control mechanism — a key issue for private companies, said Zhao Jian, a professor at Beijing Jiaotong University’s School of Economics and Management.

All of the nation’s railroads operate under a unified tariff system. Transportation companies, for example, must follow freight rates approved by NDRC.

The ministry “has a very positive attitude toward introducing private capital,” said Zhao. “But breaking the glass door that obstructs private capital investment is not only an issue for the investment and financing system, but should involve deep reform for the ministry.”

Private capital sniffs out profit-making potential, Zhao said, and may turn up its nose at rail projects for which it cannot set money-making prices. Existing passenger lines in China, he said, often lose money.

“Rail transportation prices are strictly controlled even though railways must haul agricultural products, provide student-discounted tickets, offer travel services during the Spring Festival period and provide other public services,” he said. “If transportation prices remain unchanged but costs rise, how can a private company make a profit?”

Another area that the ministry has yet to touch with reform proposals is its tight control over all train schedules. Scheduling is critical in China where passenger demand can soar suddenly, such as during Spring Festival, and dramatically impact freight traffic along with any private cargo services.

Diving in

Because the ministry’s latest reform plans have yet to graduate from the study phase, private companies have expressed caution toward their possible involvement in direct investments in railway construction, operations and management.

But some companies say they’re willing to work with the ministry on engineering, construction, locomotive manufacturing and railway services.

“As long as there’s money to be made, private companies are willing to dive in,” an official at a railway supply company said.

In fact, railway engineering companies several years ago started breaking into the business by subcontracting under ministry-connected enterprises such as China Railway Group and China Railway Construction Corp.

BMW and Audi sales continue to roar

(3:05)

BMW's global car sales continued to rise in May as demand in China more than offset weaker sales in Europe, leaving it on course for a new sales record this year.

But since government companies are always the lead contractors, some subcontractors have been unable to protect themselves from late payment and default risks.

Doing business with the ministry can also force companies to bend on product quality and safety, said one supplier, since winning a contract can require offering goods or services at below cost.

Last year, the ministry started using independent agencies to process tenders in certain areas, such as Beijing, and replace the work of the railway administrations. As a result, a wider variety of experts are joining ministry officials to evaluate bids which, according to one supplier, raises costs but makes it hard for participants to cultivate personal relationships with government officials in order to manipulate tenders.

Potential private investors and ministry officials have in the past discussed possible ways to divide revenues paid by passengers and freight clients when two or more intercity railways are separately owned. Negotiations were especially keen before the 2007 launch of the Beijing-Shanghai High Speed Rail Co. Ltd., which started with 110 billion yuan ($17.4 billion) and today operates the high-speed railway between the cities.

China Ping An Insurance and six venture capital firms bought a 13.9% stake in the high-speed railway for 16 billion yuan, while the government’s National Social Security Fund Council invested 10 billion yuan. The remaining 80% of Beijing-Shanghai line is controlled by the railways ministry and eight investment companies controlled by local governments.

A National Audit Office report in March said 5.1 billion yuan worth of passenger tickets were sold during the line’s first four months in operation — from June 30, 2011, to the end of October.

But revenue-sharing issues connected to the Beijing-Shanghai bullet trains have yet to be settled.

“This is a good line, but the Ministry of Railways has not clarified whether connecting-line revenues belong to the Beijing-Shanghai high-speed joint-stock company,” a source close to the company said. “The profits we deserve are not guaranteed.”

Another investor said connecting-line passenger tickets could account for 30% of all revenues for high-speed railways after the nationwide system is completed in 2015.

Ministry officials told investors in 2006 the line would cost about 160 billion yuan, but within a year the budget swelled to 220 billion yuan. And revenues derived from ticket sales have been hurt by a ministry decision to reduce speeds following last year’s deadly collision of two bullet trains.

Intraday Data provided by SIX Financial Information and subject to terms of use.
Historical and current end-of-day data provided by SIX Financial Information. Intraday data
delayed per exchange requirements. S&P/Dow Jones Indices (SM) from Dow Jones & Company, Inc.
All quotes are in local exchange time. Real time last sale data provided by NASDAQ. More
information on NASDAQ traded symbols and their current financial status. Intraday
data delayed 15 minutes for Nasdaq, and 20 minutes for other exchanges. S&P/Dow Jones Indices (SM)
from Dow Jones & Company, Inc. SEHK intraday data is provided by SIX Financial Information and is
at least 60-minutes delayed. All quotes are in local exchange time.